Here's an interesting chart showing convergence of rolling 10 year returns across the Ivy League endowments. Despite the recent rebound in returns, it has been harder for endowments to differentiate their performance vs. peers, unlike the amazing dispersion among the Ivies during the era from the end of the Internet Bubble up until the 2008 Great Financial Crisis.
"To gain alpha, institutional investors have many avenues. For large investors, the endowment model has traditionally worked well. However, it can lead to overdiversification and pose challenges for smaller investors looking to replicate the model, according to a new paper."
Alpha can be generated in many ways. Since asset allocation plays a big role in determining portfolio returns, it is interesting to see how beta (or index fund) portfolios compare to sophisticated institutional investors. Given its complexity, the Endowment Model is not a one-size-fits-all strategy, and is best suited for larger investment teams with considerable resources. For those institutions constrained by limited resources, using a balance of alternative assets and beta could achieve the best of both worlds.
Many endowments have suffered from low 10y annualized returns over the past decade, falling short of their rough 7% return hurdles of spending + inflation. That is why it is heartening to see the 10y annualized return for the S&P 500 finally exceed 10% as of the fiscal year ending June 30, 2018, the first time since FY 2005.
The similarity in performance between endowments and public pensions will likely persist as public pension portfolios continue to look more like those of endowments. Public pensions have ramped up use of alternatives in the hope of achieving higher returns to close widening funding gaps. Public pensions also have similar target returns of 7-8% versus endowments' return hurdles of roughly 5% spending + inflation.
The 5y chart clearly proves the Endowment Model adds value for many, yet it delivers a wide range of outcomes. So the question is not if the Endowment Model works or not, but “Does it work for your institution?” Those who consistently underperform a basic benchmark with higher risk (in the worst quadrant) are jeopardizing their long-term missions. Fiduciaries have a responsibility to consider a better investment solution which may include index funds to improve performance and portfolio structure.
While a US 60/40 continues to be a formidable benchmark to beat, it is not nearly as diversified for the modern needs of our global world. The Endowment Model is constantly evolving to find new sources of alpha, so don't count it out just yet.
However, a one size solution does not suit all investors, and even a well-designed beta portfolio of index funds could deliver alpha.
Whether building a first class Endowment Model portfolio or an index fund strategy, both risk and return expectations must be considered when hoping to achieve one's long-term investment goals.
The 70/30 and 60/40 balanced benchmarks hint at what the average annual endowment return might be for FY 2018 (for the 12 months ending June 30, 2018).
This paper takes a close look at the performance differences between the Endowment Model and Public Pensions across various cycles. The lucrative illiquidity premium has generated superior returns for U.S. endowments versus U.S. public pensions, mainly during the 1990s internet bubble, and until the 2008 financial crisis. Smaller investors struggle to run an endowment portfolio, proof that a one size strategy does not fit all investors. Thus, the possible alternative option could be a well-designed index fund strategy that focuses on superior risk-adjusted returns and doesn’t have the same pitfalls that the endowment model inherently has.
Some alumni recently recommended placing half of Harvard’s endowment into the S&P 500. They have good intentions as they look to save on fees. They are also inspired by Warren Buffet winning his bet on the S&P 500 beating hedge funds over a 10 year period, and by the S&P 500 trouncing Harvard since 2008. Yet, investing now is chasing past performance.
Moreover, the S&P 500 would introduce much more risk into the mix, while substantially reducing diversification. And it assumes they can successfully time the markets, something even the best managers cannot consistently do. Instead, the Harvard community should give the current team time to transform the portfolio into a world class endowment once again.
The outperformance of the large $1+ billion endowments vs the 70/30 global stocks/US bonds balanced benchmark can be seen in this graph of a rolling 3 year annualized return average from 6/30/1989 to 6/30/2017.
This updated chart shows the NCSE endowment return average continues to be historically within the ballpark of the 70/30 and 60/40 (global stocks/US bonds) balanced benchmarks.
Trusted Insight posted a second interview with Steve Edmundson, CIO of Public Employees' Retirement System of Nevada. I find inspiring parallels between NVPERS’ investment philosophy for their $38.5 billion pension, and my own strategy, the EndowBridge Legacy Strategy.
Quote in P&I Article: U.S. and Canadian endowments are struggling after producing the worst average annual return since the financial crisis low point resulting in an aggregate asset drop of 2.6%.
“A low-return environment could very well persist in the near term, making it more challenging to achieve returns that keep pace with an endowment return hurdle of inflation plus spending, which require returns to be better than 7% to 8% over the long run,” said Michael Karris, president of EndowBridge Capital LLC, Princeton, N.J.
Some investment industry folks run endowment performance comparisons, and others perform public pension return comparisons. Here's an interesting comparison of returns of 20 of the largest US endowments to 20 of the largest US public pensions. I know it's an apples to oranges comparison, given the different mission/investment style of each investor group. However, they both were influenced historically by a 60/40 benchmark, and their investment styles have converged over time.
Investment manager performance is often initially ranked using returns, but equally important is how risky are those investment returns. Performance assessment is often time period dependent, and as such rolling periods of risk-return analysis could be helpful to see longer-term trends. Other metrics also should be considered, like to what degree could illiquidity and complexity affect an endowment portfolio during a financial crisis.
Here's a graph of average endowment returns vs some benchmarks I follow. It could serve as a rough estimate of what the average FY 2017 endowment return might be (for the 12 months ending June 2017).
By now most endowment industry followers have read the articles detailing Yale endowment’s David Swensen’s response to the critics of fees, which was the subject of this Bloomberg article by Janet Lorin, and this article by Nir Kaissar.
The message in the article "Endowment Sweepstakes: How Tiny Houghton College Beat Harvard" supports the premise of the EndowBridge Legacy Strategy, that a well designed passive strategy of index funds can deliver superior results (than the traditional 60/40 mix) for smaller endowments and foundations.
In his article, Why Colleges Are Getting a 'C' in Investing, Mr. Lowenstein makes a comprehensive list of very thoughtful observations regarding the challenges faced by the modern endowment model. I would like to expand upon the subject of “unnecessary complexity,” cited as one of the reasons for poor endowment performance.
Lots of articles and books discuss backtested index-fund-based portfolios that try to replicate the fabled modern endowment model.
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